26 U.S.C. § 422: Incentive stock options

§ 1.422-1 Incentive stock options; general rules.§ 1.422-2 Incentive stock options defined.§ 1.422-3 Stockholder approval of incentive stock option plans.§ 1.422-4 $100,000 limitation for incentive stock options.§ 1.422-5 Permissible provisions.

Amended 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(9)(A)(i), renumbered section 422A of this title as this section.

Cases: Montgomery v. Commissioner, 127 T.C. 43 (2006)

Final rules 2

(a) In general Section 421(a) shall apply with respect to the transfer of a share of stock to an individual pursuant to his exercise of an incentive stock option if—

“with respect to the transfer of a share of stock to an individual pursuant to his exercise of an incentive stock option” Opening words

Textual readingALL OF= Section 421(a) applies to the transfer

(1) no disposition of such share is made by him within 2 years from the date of the granting of the option nor within 1 year after the transfer of such share to him, and

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(2) at all times during the period beginning on the date of the granting of the option and ending on the day 3 months before the date of such exercise, such individual was an employee of either the corporation granting such option, a parent or subsidiary corporation of such corporation, or a corporation or a parent or subsidiary corporation of such corporation issuing or assuming a stock option in a transaction to which section 424(a) applies.

Amended 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(9)(C)(i), substituted “424(a)” for “425(a)”.

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(b) Incentive stock option For purposes of this part, the term “incentive stock option” means an option granted to an individual for any reason connected with his employment by a corporation, if granted by the employer corporation or its parent or subsidiary corporation, to purchase stock of any of such corporations, but only if—

Amended 1983, 1986, 1988, 2017

2017 Pub. L. 115-97 Pub. L. 115–97 inserted at end of concluding provisions “Such term shall not include any option if an election is made under section 83(i) with respect to the stock received in connection with the exercise of such option.”
1988 Pub. L. 100-647 Pub. L. 100–647, § 1003(d)(1)(A), inserted at end “Such term shall not include any option if (as of the time the option is granted) the terms of such option provide that it will not be treated as an incentive stock option.”
1988 Pub. L. 100-647 Pub. L. 100–647, § 1003(d)(2)(B), struck out par. (7) which read as follows: “under the terms of the plan, the aggregate fair market value (determined at the time the option is granted) of the stock with respect to which incentive stock options are exercisable for the 1st time by such individual during any calendar year (under all such plans of the individual’s employer corporation and its parent and subsidiary corporations) shall not exceed $100,000.”
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(a), added par. (7) and struck out former par. (7) which read as follows: “such option by its terms is not exercisable while there is outstanding (within the meaning of subsection (c)(7)) any incentive stock option which was granted, before the granting of such option, to such individual to purchase stock in his employer corporation or in a corporation which (at the time of the granting of such option) is a parent or subsidiary corporation of the employer corporation, or in a predecessor corporation of any of such corporations; and”.
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(a), struck out par. (8) which read as follows: “in the case of an option granted after December 31, 1980, under the terms of the plan the aggregate fair market value (determined as of the time the option is granted) of the stock for which any employee may be granted incentive stock options in any calendar year (under all such plans of his employer corporation and its parent and subsidiary corporation) shall not exceed $100,000 plus any unused limit carryover to such year.”
1983 Pub. L. 97-448 Pub. L. 97–448, § 102(j)(1), substituted “granted incentive stock options” for “granted options”.

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(1) the option is granted pursuant to a plan which includes the aggregate number of shares which may be issued under options and the employees (or class of employees) eligible to receive options, and which is approved by the stockholders of the granting corporation within 12 months before or after the date such plan is adopted;

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(2) such option is granted within 10 years from the date such plan is adopted, or the date such plan is approved by the stockholders, whichever is earlier;

(3) such option by its terms is not exercisable after the expiration of 10 years from the date such option is granted;

(4) the option price is not less than the fair market value of the stock at the time such option is granted;

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(5) such option by its terms is not transferable by such individual otherwise than by will or the laws of descent and distribution, and is exercisable, during his lifetime, only by him; and

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(6) such individual, at the time the option is granted, does not own stock possessing more than 10 percent of the total combined voting power of all classes of stock of the employer corporation or of its parent or subsidiary corporation.

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Such term shall not include any option if (as of the time the option is granted) the terms of such option provide that it will not be treated as an incentive stock option. Such term shall not include any option if an election is made under section 83(i) with respect to the stock received in connection with the exercise of such option.

Amended 1984, 1986, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(9)(C)(ii), redesignated pars. (6) to (8) as (5) to (7), respectively, and struck out former par. (5) “Coordination with sections 422 and 424” which read as follows: “Sections 422 and 424 shall not apply to an incentive stock option.”
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(1)(B), redesignated par. (10) as (8). Former par. (8) redesignated (6).
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(1)(B), redesignated par. (9) as (7).
1986 Pub. L. 99-514 Pub. L. 99–514, § 1847(b)(5), substituted “section 22(e)(3)” for “section 37(e)(3)”.
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(1)(B), redesignated par. (10) as (8).
1984 Pub. L. 98-369 Pub. L. 98–369, § 2662(f)(1), substituted “section 37(e)(3)” for “section 105(d)(4)”.
1984 Pub. L. 98-369 Pub. L. 98–369, § 555(a)(1), added par. (10).

(1) Good faith efforts to value stock If a share of stock is transferred pursuant to the exercise by an individual of an option which would fail to qualify as an incentive stock option under subsection (b) because there was a failure in an attempt, made in good faith, to meet the requirement of subsection (b)(4), the requirement of subsection (b)(4) shall be considered to have been met. To the extent provided in regulations by the Secretary, a similar rule shall apply for purposes of subsection (d).

Amended 1983, 1986, 1988

1988 Pub. L. 100-647 Pub. L. 100–647, § 1003(d)(2)(C), substituted “subsection (d)” for “paragraph (7) of subsection (b)”.
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(2), substituted “paragraph (7) of subsection (b)” for “paragraph (8) of subsection (b) and paragraph (4) of this subsection”.
1983 Pub. L. 97-448 Pub. L. 97–448, § 102(j)(2), substituted “Good faith efforts to value stock” for “Exercise of option when price is less than value of stock” as par. (1) heading and inserted sentence providing that, to the extent provided in regulations by the Secretary, a rule similar to that already enunciated in the paragraph applies for purposes of par. (8) of subsec. (b) and par. (4) of subsec. (c).

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(2) Certain disqualifying dispositions where amount realized is less than value at exercise If—

(A) an individual who has acquired a share of stock by the exercise of an incentive stock option makes a disposition of such share within either of the periods described in subsection (a)(1), and

Amended 1983

1983 Pub. L. 97-448 Pub. L. 97–448, § 102(j)(3), substituted “either of the periods” for “the 2-year period”.

(B) such disposition is a sale or exchange with respect to which a loss (if sustained) would be recognized to such individual,

then the amount which is includible in the gross income of such individual, and the amount which is deductible from the income of his employer corporation, as compensation attributable to the exercise of such option shall not exceed the excess (if any) of the amount realized on such sale or exchange over the adjusted basis of such share.

(3) Certain transfers by insolvent individuals If an insolvent individual holds a share of stock acquired pursuant to his exercise of an incentive stock option, and if such share is transferred to a trustee, receiver, or other similar fiduciary in any proceeding under title 11 or any other similar insolvency proceeding, neither such transfer, nor any other transfer of such share for the benefit of his creditors in such proceeding, shall constitute a disposition of such share for purposes of subsection (a)(1).

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(4) Permissible provisions An option which meets the requirements of subsection (b) shall be treated as an incentive stock option even if—

Amended 1986

1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(1), redesignated par. (5) as (4) and struck out former par. (4) relating to carryover of unused limit.

(A) the employee may pay for the stock with stock of the corporation granting the option,

Amended 1983

1983 Pub. L. 97-448 Pub. L. 97–448, § 102(j)(4), substituted “granted incentive stock options” for “granted options”.

(B) the employee has a right to receive property at the time of exercise of the option, or

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Subparagraph (B) shall apply to a transfer of property (other than cash) only if section 83 applies to the property so transferred.

(5) 10-percent shareholder rule Subsection (b)(6) shall not apply if at the time such option is granted the option price is at least 110 percent of the fair market value of the stock subject to the option and such option by its terms is not exercisable after the expiration of 5 years from the date such option is granted.

Textual readingALL OF= subsection (b)(6) does not apply

“at the time such option is granted the option price is at least 110 percent of the fair market value of the stock subject to the option”

“such option by its terms is not exercisable after the expiration of 5 years from the date such option is granted”

Amended 1986, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(9)(C)(ii), redesignated pars. (6) to (8) as (5) to (7), respectively, and struck out former par. (5) “Coordination with sections 422 and 424” which read as follows: “Sections 422 and 424 shall not apply to an incentive stock option.”
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(1)(B), redesignated pars. (6) and (8) as (5) and (6), respectively. Former par. (5) redesignated (4).

(6) Special rule when disabled For purposes of subsection (a)(2), in the case of an employee who is disabled (within the meaning of section 22(e)(3)), the 3-month period of subsection (a)(2) shall be 1 year.

Amended 1986, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(9)(C)(ii), redesignated pars. (6) to (8) as (5) to (7), respectively, and struck out former par. (5) “Coordination with sections 422 and 424” which read as follows: “Sections 422 and 424 shall not apply to an incentive stock option.”
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(1)(B), redesignated pars. (6) and (8) as (5) and (6), respectively. Former par. (5) redesignated (4).

(7) Fair market value For purposes of this section, the fair market value of stock shall be determined without regard to any restriction other than a restriction which, by its terms, will never lapse.

Amended 1986, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(9)(C)(ii), redesignated pars. (6) to (8) as (5) to (7), respectively, and struck out former par. (5) “Coordination with sections 422 and 424” which read as follows: “Sections 422 and 424 shall not apply to an incentive stock option.”
1986 Pub. L. 99-514 Pub. L. 99–514, § 321(b)(1), redesignated par. (9) as (7) and struck out former par. (7) which provided that for purposes of subsec. (b)(7) any incentive stock option be treated as outstanding until such option was exercised in full or expired by reason of lapse of time.

(d) $100,000 per year limitation

Amended 1988

1988 Pub. L. 100-647 Pub. L. 100–647, § 1003(d)(2)(A), added subsec. (d).

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(1) In general To the extent that the aggregate fair market value of stock with respect to which incentive stock options (determined without regard to this subsection) are exercisable for the 1st time by any individual during any calendar year (under all plans of the individual’s employer corporation and its parent and subsidiary corporations) exceeds $100,000, such options shall be treated as options which are not incentive stock options.

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(2) Ordering rule Paragraph (1) shall be applied by taking options into account in the order in which they were granted.

(3) Determination of fair market value For purposes of paragraph (1), the fair market value of any stock shall be determined as of the time the option with respect to such stock is granted.